Over the summer, Delaware in two separate and impactful decisions hit out at many, if not most, shareholder litigation suits challenging public company M&A suits. The result: uncertainty ahead.
The customary rhythm in an M&A deal historically went something like this: two parties entered into an acquisition contract and filed pertinent disclosure documents with the SEC. Plaintiffs law firms would jockey furiously for position as lead counsel in a class action under state law challenging the sufficiency of the disclosure documents, if not the underlying substantive fairness of the transaction.
In the last two decades, the frequency of lawsuits in M&A transactions has steadily and seemingly inevitably crept up from “likely” to “almost certain” to “certain” in any transaction of material value. There always has seemed to be something missing from disclosure documents, whether some financial metrics in the investment banker analyses or details, sometimes perhaps quite miniscule, from the definitive agreement. It also has not generally been helpful to companies that these disclosure documents are often hastily prepared and slapped on file to satiate the acute hunger to quickly check off another box on the pre-closing checklist. Even in a proxy-vote deal, the alternative to a tender offer, where other closing conditions, such as union negotiations or anti-trust approvals, may be months away, the quicker the disclosure documents are filed and the stockholder vote is held, the quicker the vulnerability of the deal to gate-crashing by a superior offer is eliminated.
Once the plaintiff’s firm and the defendant (the public company target company) agreed to additional disclosures, they would then agree on a tidy fee for the plaintiff’s firm, often in the range from $250,000 – $500,000. Such a fee, however, was modest in proportion to a transaction’s value or even aggregate transaction expenses. In return, the defendant would obtain from the class (i.e. the defendant’s stockholders) a very muscular, universal release from any other future deal-related litigation. In other words, defendants would, for a few hundred thousand dollars − which pales in comparison to the average investment banking fee on a transaction − both make the plaintiff’s (nuisance?) lawsuit go away and, equally importantly, ensure that no other litigation related to the deal would likely emerge thanks to the release. Call it deal certainty insurance. Call it greenmail. Call it very lucrative for the Delaware plaintiff’s bar. Call it a deal tax on public company acquisitions. Call it what you may.
None of the parties involved in this process had much incentive to rock the boat. Individual companies (those being sold, at that) were preoccupied with larger existential matters. The Delaware plaintiff’s bar made out well. And there was no mass refusal by companies to stop incorporating in Delaware that might nudge the Delaware legislature into action − recall that Delaware politicians are perfectly willing to preserve fiefdoms with things like banning fee-shifting bylaws without considering compromise positions.
At many a board meeting, directors would merely roll their eyes when briefed on the possibility of unseemly disclosure-only litigation. But the allure of a universal release would generally make directors stomach what otherwise seemed an unpalatable use of stockholder money.
Increasingly, however, in the past couple of years there have been challenges to fee-only disclosures. Delaware judges first began by slowly but steadily reducing fee awards for truly disclosure-only settlements. In turn, plaintiff law firms cleverly began asking for other non-disclosure remedies – although such measures often have seemed more window dressing than substance. During 2013 and 2014, faint tremors were felt: a few cases arose under which settlements were significantly reduced by judges for having resulted in less than world-changing disclosures for the “total mix of information.” However, as of this year, the situation still appeared somewhat stable – if you could call “stable” a delicate balance. This summer, the balance began to fail, and the tremors of 2013 – 2014 became serious jolts.
Enter Vice Chancellor Travis Laster’s July 2015 decision in the roughly $1.5 billion acquisition of private equity-controlled Aeroflex Holding Corp. by British defense manufacturer Cobham PLC, and Vice Chancellor Sam Glasscock’s September 2015 decision in the $3.6 billion acquisition of Riverbed Technology by private equity firm Thoma Bravo and the Ontario Teachers’ Pension Plan.
In the case involving Aeroflex, the parties agreed to reduce the break-up fee from $32 million to $18 million − both numbers are quite reasonable as percentages of deal value – and reduce the match period – the time in which the proposed acquirer could match an offer from an interloper – by a whopping full day from four days to three days. In return, the plaintiff’s firm requested over $800,000 in fees. Laster threw the settlement out of court on its face as being a solution unrelated to a purported problem. He expounded that neither the break-up fee or the match period reduction were demonstrated as the reasons why another party had not broken up the deal with a superior offer. Plaintiff’s fees: zero.
In the case involving Riverbed Technology, a San Francisco technology firm that in recent years had found itself under loud, public pressure from an activist investor, the company unilaterally made changes to the proxy statement between its preliminary filing and its definitive filing, as well as agreeing to some supplemental changes thereafter. The parties also agreed for Riverbed to fork over $500,000 to cover plaintiffs’ attorneys fees. Not a single stockholder objector was to be found, until along came a law professor at Fordham, Sean Griffith, who purchased shares of Riverbed after the deal had already been signed. Griffith in this instance could be uncharitably seen as an academic activist (gadfly?), but his credentials are not unimpressive, given a law degree from Harvard followed by a stint at Wachtell Lipton. Vice Chancellor Sam Glasscock’s first order of business in his opinion was to swat away assertions by the parties that a stockholder who acquired shares after the signing of the acquisition agreement would lack standing.
Vice Chancellor Glasscock then reached a transitory middle ground. He allowed the settlement, but only on the grounds that the parties had expected to be able to reach such a deal and thus it would be unfair to change the legal rules they had relied upon. Ummm. OK. Pragmatism reigns.
Vice Chancellor Glasscock noted:
- The existence of the “agency” problem creates the appearance that no actual adversarial relationship exists during negotiations between a company under scrutiny and a plaintiff’s firm.
- Even though some of the disclosure (surrounding, drum roll… the financial adviser) arguably could have helped stockholders in evaluating negative reasons for, or at least perhaps potential conflicts of interest in, in the transaction, despite the amended disclosures, 99.48 percent of stockholders still voted in favor of the deal.
- The supplemental disclosures appear to be a “peppercorn” because of the lack of apparent other claims – but conversely, for this same reason, the prospect of a universal release in this specific deal seemed like a “mustard seed” and thus the present settlement could squeak through without material harm likely arising from granting the universal release.
While Vice Chancellor Glasscock pared back the plaintiff’s fee to a still-healthy $300,000, he made clear that future settlements would not receive such favorable treatment – and that, in combination with the decision in the Aeroflex deal, the window on cozy quid pro quo settlements, in Delaware at least, has closed. The faint tremors of 2013 – 2014 haves officially shaken the earth – and while disclosure-only settlements are not necessarily eliminated, the ground has been materially changed, so much so that one would posit that the number of such future suits in Delaware should diminish substantially.
In recent comments, members of the Delaware judiciary have shared their distrust that companies have already started to sneak away to state courts elsewhere that may uphold disclosure-based settlements and thereby grant a universal litigation release. Ironically, in order for these companies to avail themselves of other state courts, they may in fact choose to waive the exclusive jurisdiction bylaw provision that has become popular in recent years and almost de rigueur for acquisition targets. This is exactly the opposite of what was postulated with exclusive forum developments.
Conversely, the same prospect of plaintiff’s firms abandoning Delaware to double down on litigation in other states should hopefully give to-be-acquired companies the fortitude to at least adopt, if not enforce, such exclusive forum bylaws. Given this potential cauldron of multi-state litigation and releases, at least one member of the Delaware bar has ruminated that the area may be keen for wholesale federal pre-emption. The feds hypothetically could take such lawsuits away entirely from state courts, as happened with general securities litigation in strike suits. Yet there hardly appears to be the political groundswell at present for that to occur in the near term.
Absent fleeing to other states or having the federal government take over an area that would seem squarely in the domain of state law interpretation, we appear headed for a period of certainty and uncertainty in Delaware. It seems increasingly certain that any shareholder lawsuit (and resulting settlement with the carrot of that tasty universal release) will need to be predicated on true substance that solves a material deal deficiency. Conversely, it seems uncertain whether that heightened standard for a settlement will simply deter plaintiff firms from filing suits in the first place and whether, in the absence of an upfront suit and release, boards may be sued well after consummation without the protection of a litigation release.
We are clearly are not at the end of this book. Stay tuned for more interesting chapters ahead.